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Wednesday, January 20, 2010

Cost Accounting : An Introduction

Cost Accounting : An Introduction

If you set up a small manufacturing unit, say manufacturing of packing boxes, a problem will
arise what price of each box you should quote to the buyer. Many factors are considered while fixing the price of a product/item such as competitors’ price etc. One of the basic factors is the cost of its production. Cost is essential not only to fix price but also to ascertain the margin of profit.
Knowledge of the cost determination is also necessary to keep a check on the cost of product/control on wastages, etc. The accounting used to study the various aspects of cost is known as cost accounting. In this lesson, you will learn about meaning, importance, limitations etc. of cost accounting.


After studying this lesson, you will be able to:
_ state the meaning and scope of cost accounting;
_ explain the objectives of cost accounting;
_ differentiate between cost accounting and financial accounting;
_ state importance of cost accounting;
_ explain limitations of cost accounting.


Cost accounting is the process of determining and accumulating the cost
of product or activity. It is a process of accounting for the incurrence and
the control of cost. It also covers classification, analysis, and interpretation
of cost. In other words, it is a system of accounting, which provides the
information about the ascertainment, and control of costs of products, or
services. It measures the operating efficiency of the enterprise. It is an
internal aspect of the organisation. Cost Accounting is accounting for cost
aimed at providing cost data, statement and reports for the purpose of
managerial decision making. The Institute of Cost and Management
Accounting, London defines “Cost accounting is the process of accounting
from the point at which expenditure is incurred or committed to the
establishment of its ultimate relationship with cost centres and cost units.
In the widest usage, it embraces the preparation of statistical data,
application of cost control methods and the ascertainment of profitability
of activities carried out or planned”.
Costing includes “the techniques and processes of ascertaining costs.” The
‘Technique’ refers to principles which are applied for ascertaining costs of
products, jobs, processes and services. The `process’ refers to day to day
routine of determining costs within the method of costing adopted by a
business enterprise.
Costing involves “the classifying, recording and appropriate allocation of
expenditure for the determination of costs of products or services; the
relation of these costs to sales value; and the ascertainment of profitability”.

Scope of Cost Accounting

The terms ‘costing’ and ‘cost accounting’ are many times used
interchangeably. However, the scope of cost accounting is broader than that
of costing. Following functional activities are included in the scope of cost
1. Cost book-keeping: It involves maintaining complete record of all costs
incurred from their incurrence to their charge to departments, products
and services. Such recording is preferably done on the basis of double
entry system.
2. Cost system: Systems and procedures are devised for proper accounting
for costs.
3. Cost ascertainment: Ascertaining cost of products, processes, jobs,
services, etc., is the important function of cost accounting. Cost
ascertainment becomes the basis of managerial decision making such
as pricing, planning and control.
4. Cost Analysis: It involves the process of finding out the causal factors
of actual costs varying from the budgeted costs and fixation of
responsibility for cost increases.
5. Cost comparisons: Cost accounting also includes comparisons between
cost from alternative courses of action such as use of technology for
production, cost of making different products and activities, and cost
of same product/ service over a period of time.
6. Cost Control: Cost accounting is the utilisation of cost information for
exercising control. It involves a detailed examination of each cost in
the light of benefit derived from the incurrence of the cost. Thus, we
can state that cost is analysed to know whether the current level of costs
is satisfactory in the light of standards set in advance.
7. Cost Reports: Presentation of cost is the ultimate function of cost
accounting. These reports are primarily for use by the management at
different levels. Cost Reports form the basis for planning and control,
performance appraisal and managerial decision making.

Objectives of cost accounting

There is a relationship among information needs of management, cost
accounting objectives, and techniques and tools used for analysis in cost
accounting. Cost accounting has the following main objectives to serve:
1. Determining selling price,
2. Controlling cost
3. Providing information for decision-making
4. Ascertaining costing profit
5. Facilitating preparation of financial and other statements.
1. Determining selling price
The objective of determining the cost of products is of main importance
in cost accounting. The total product cost and cost per unit of product
are important in deciding selling price of product. Cost accounting
provides information regarding the cost to make and sell product or
services. Other factors such as the quality of product, the condition of
the market, the area of distribution, the quantity which can be supplied
etc., are also to be given consideration by the management before
deciding the selling price, but the cost of product plays a major role.
2. Controlling cost
Cost accounting helps in attaining aim of controlling cost by using
various techniques such as Budgetary Control, Standard costing, and
inventory control. Each item of cost [viz. material, labour, and expense]
is budgeted at the beginning of the period and actual expenses incurred
are compared with the budget. This increases the efficiency of the
3. Providing information for decision-making
Cost accounting helps the management in providing information for
managerial decisions for formulating operative policies. These policies
relate to the following matters:
(i) Determination of cost-volume-profit relationship.
(ii) Make or buy a component
(iii) Shut down or continue operation at a loss
(iv) Continuing with the existing machinery or replacing them by
improved and economical machines.
4. Ascertaining costing profit
Cost accounting helps in ascertaining the costing profit or loss of any
activity on an objective basis by matching cost with the revenue of the
5. Facilitating preparation of financial and other statements
Cost accounting helps to produce statements at short intervals as the
management may require. The financial statements are prepared generally
once a year or half year to meet the needs of the management. In order
to operate the business at high efficiency, it is essential for management
to have a review of production, sales and operating results. Cost
accounting provides daily, weekly or monthly statements of units
produced, accumulated cost with analysis. Cost accounting system
provides immediate information regarding stock of raw material, semifinished
and finished goods. This helps in preparation of financial


After studying financial accounting and cost accounting, you can understand
the difference between these two accounting systems. Therefore, difference
between financial accounting and cost accounting is as follows:
Table 27.1 Differences between financial accounting and cost accounting
Basis Financial Accounting Cost accounting
(i) Objective It provides information about It provides information of
the financial performance and ascertainment of cost to control
financial position of the cost and for decision making
business. about the cost.
(ii) Nature It classifies records, presents It classifies, records, presents,
and interprets transactions in and interprets in a significant
terms of money. manner the material, labour and
overheads cost.
(iii) Recording It records Historical data. It also records and presents the
of data estimated/budgeted data. It
makes use of both the historical
costs and pre-determined costs..
(iv) Users of The users of financial The cost accounting information
information accounting statements are is used by internal management
shareholders, creditors, at different levels.
financial analysts and
government and its agencies,
(v) Analysis of It shows the profit/ loss of the It provides the details of cost and
costs and organisation. profit of each product, process,
profits job, contracts, etc.
(vi) Time period Financial Statements are Its reports and statements are
prepared for a definite period, prepared as and when required.
usually a year.
(vii) Presentation A set format is used for There are not any set formats for
of information presenting financial presenting cost information.
In spite of the above differences, both financial and cost accounting are in
agreement regarding actual cost data and product costing analysis. Values
of stock and cost of goods produced and sold are the main examples. For
the preparation of the position statement, financial accountant receives the
necessary data from the cost accountant.
Importance of Cost accounting
The limitation of financial accounting has made the management to realise
the importance of cost accounting. The importance of cost accounting are
as follows:
1. Importance to Management
Cost accounting provides invaluable help to management. It is difficult
to indicate where the work of cost accountant ends and managerial
control begins. The advantages are as follows :
Helps in ascertainment of cost
Cost accounting helps the management in the ascertainment of cost of
process, product, Job, contract, activity, etc., by using different techniques
such as Job costing and Process costing.
Aids in Price fixation
By using demand and supply, activities of competitors, market condition
to a great extent, also determine the price of product and cost to the
producer does play an important role. The producer can take necessary
help from his costing records.
Helps in Cost reduction
Cost can be reduced in the long-run when cost reduction programme
and improved methods are tried to reduce costs.
Elimination of wastage
As it is possible to know the cost of product at every stage, it becomes
possible to check the forms of waste, such as time and expenses etc.,
are in the use of machine equipment and material.
Helps in identifying unprofitable activities
With the help of cost accounting the unprofitable activities are
identified, so that the necessary correct action may be taken.
Helps in checking the accuracy of financial account
Cost accounting helps in checking the accuracy of financial account
with the help of reconciliation of the profit as per financial accounts
with the profit as per cost account.
Helps in fixing selling Prices
It helps the management in fixing selling prices of product by providing
detailed cost information.
Helps in Inventory Control
Cost furnishes control which management requires in respect of stock
of material, work in progress and finished goods.
Helps in estimate
Costing records provide a reliable basis upon which tender and
estimates may be prepared.
2. Importance to Employees
Worker and employees have an interest in which they are employed. An
efficient costing system benefits employees through incentives plan in
their enterprise, etc. As a result both the productivity and earning
capacity increases.
3. Cost accounting and creditors
Suppliers, investor’s financial institution and other moneylenders have
a stake in the success of the business concern and therefore are benefited
by installation of an efficient costing system. They can base their
judgement about the profitability and prospects of the enterprise upon
the studies and reports submitted by the cost accountant.
4. Importance to National Economy
An efficient costing system benefits national economy by stepping up
the government revenue by achieving higher production. The overall
economic developments of a country take place due to efficiency of
5. Data Base for operating policy
Cost Accounting offers a thoroughly analysed cost data which forms the
basis of formulating policy regarding day to day business, such as:
(a) Whether to make or buy decisions from outside?
(b) Whether to shut down or continue producing and selling at below
(c) Whether to repair an old plant or to replace it?
Write against each of the following indicating the party i.e. management,
employees and creditors, benefitted from cost accounting :
1. Using budgetary control and standard costing, costing used to control
material cost, labour cost, etc.
2. Installation of an efficient costing system results in the increase in
productivity and earnings capacity.
3. Studies and reports submitted by the cost accountant enables judging
the profitability and prospects of the enterprise.
4. It enables to check the wastage in term of time and expenses.
Like other branches of accounting, cost accounting is not an exact science
but is an art which has developed through theories and accounting practices
based on reasoning and common sense. These practices are not static but
changing with time. Cost accounting lacks a uniform procedure. There is
no stereotyped system of cost accounting applicable to all industries. There
are widely recognised cost concepts but understood and applied differently
by different industries. Cost accounting can be used only by big enterprises.
The limitations of cost accounting are as follows:
_ It is expensive because analysis, allocation and absorption of overheads
require considerable amount of additional work.
_ The results shown by cost accounts differ from those shown by financial
accounts. Preparation of reconciliation statements frequently is necessary
to verify their accuracy. This leads to unnecessary increase in workload.
_ It is unnecessary because it involves duplication of work. Some
industrial units are functioning efficiently without any costing system.
_ Costing system itself does not control costs. If the management is alert
and efficient, it can control cost without the help of the cost accounting.
Therefore it is unnecessary.
_ Cost accounting is the process of determining and accumulating the cost
of product or activity.
_ There is a relationship among information needs of management, cost
accounting objectives, and techniques and tools used for analysis in cost
accounting. Cost accounting has the following main objectives:
Determining selling price,
Controlling cost
Providing information for decision-making
Ascertaining costing profit
Facilitating preparation of financial and other statements.
_ Difference between Financial accounting and Cost accounting:
After studying financial accounting and cost accounting, you can
understand the difference between these two accounting systems.
Objective Nature
Recording of data Accounting system
Users of information Analysis of costs and profits
Presentation of information
_ Importance of Cost accounting
Importance to Management:
Importance to Employees
Cost accounting and creditors
Importance to National Economy
_ Limitations of cost accounting
It is expensive
The results shown by cost accountant differ from those shown by
financial accountant.
It is unnecessary because it involves duplication of work.
l. State the meaning and scope of cost accounting.
2. Explain the objectives of cost accounting.
3. Differentiate between cost accounting and financial accounting
4. What is the importance of cost accounting in a production unit?
5. State the limitation of cost accounting.

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